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OPPORTUNITY COST, PRODUCTION POSSIBILITIES: The production possibilities analysis, which is the alternative combinations of two goods that an economy can produce with given resources and technology, can be used to illustrate opportunity cost--the highest valued alternative foregone in the pursuit of an activity.

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DISEQUILIBRIUM, LONG-RUN AGGREGATE MARKET:

The state of the aggregate market in which real aggregate expenditures are NOT equal to full-employment real production, which results in an imbalance that induces a change in the price level and aggregate expenditures. In other words, the opposing forces of aggregate demand (the buyers) and aggregate supply (the sellers) are out of balance. At the existing price level, either the four macroeconomic sectors (household, business, government, and foreign) are unable to purchase all of the real production that they seek or producers are unable to sell all of the full-employment real production that they have.
Disequilibrium in the long-run aggregate market, strictly speaking, means that an imbalance exists between demand and supply in the aggregate product markets. It does not necessarily mean that imbalances exist in the other two aggregated markets--financial and resource. In fact, the relative speed of adjustment for the three markets suggests that financial markets are likely to be in equilibrium, while resource markets may or may not be in equilibrium.

Working a Graph

Disequilibrium
Long-Run Aggregate Market
Disequilibrium

The standard graphical representation of the long-run aggregate market is presented in the exhibit to the right. The vertical axis measures the price level (GDP price deflator) and the horizontal axis measures real production (real GDP). This graph includes two curves. The negatively-sloped aggregate demand curve is labeled AD. The vertical long-run aggregate supply curve is labeled LRAS. For reference, equilibrium is indicated by the intersection of the two curves at price level 10.

Disequilibrium in the long-run aggregate market results at price levels that do not correspond to intersection of the AD curve and the LRAS curve. Consider two alternatives to illustrate:

  • Higher Price Level: Suppose that the price level is above the equilibrium value of 10. Such a price level can be displayed by clicking the [Higher Price Level] button. Disequilibrium in the long-run aggregate market results if the price level has a value of 11. This price level does not correspond to the intersection of the two curves. In particular, aggregate demand is less than long-run aggregate supply, meaning aggregate expenditures are less than full-employment real production. Producers are unable to sell all of their real production. The result is economy-wide product market surpluses.

  • Lower Price Level: Now suppose that the price level is below the equilibrium value of 10. This particular price level can be displayed by clicking the [Lower Price Level] button. Disequilibrium in the long-run aggregate market also results if the price level has a value of 9. This price level also fails to correspond to the intersection of the two curves. In this case, aggregate demand is greater than long-run aggregate supply, meaning aggregate expenditures are greater than full-employment real production. Buyers are unable to buy all of the real production they seek. The result is economy-wide product market shortages.

Short and Long

Disequilibrium can arise in both the long-run aggregate market and the short-run aggregate market. However, disequilibrium in one time frame does not necessarily mean disequilibrium in the other.

In particular, disequilibrium in the long-run aggregate market does not necessarily mean disequilibrium in the short-run aggregate market. That is, a given price level might correspond to the intersection of the aggregate demand curve and the short-run aggregate supply curve, but not the intersection of the aggregate demand curve and the long-run aggregate supply curve. This is, in fact, the essence of short-run equilibrium--aggregate expenditures match short-run real production, but NOT long-run, full-employment real production.

In contrast, disequilibrium in the short-run aggregate market does necessarily mean disequilibrium in the long-run aggregate market. If aggregate expenditures do not match real production, then they fail to match real production generated in the short-run as well as that generated in the long run at full employment.

Adjustment to Equilibrium

The basic adjustment mechanism that restores equilibrium in the long-run aggregate market is essentially the same as that for the standard market model. Imbalances between aggregate demand and long-run aggregate supply induce changes in the price level that ultimately achieve equilibrium.

A key feature of this adjustment process for the long run is that price level changes induce changes in aggregate expenditures but NOT changes in real production. The reason is that long-run aggregate supply is full-employment real production, which is unaffected by the price level. The ONLY way to restore balance in the long-run equilibrium aggregate market is changes in aggregate expenditures. In fact, the price level MUST continue to change until aggregate expenditures are EXACTLY equal to full-employment real production.

  • Suppose, for example, that the price level happens to be above the equilibrium, such as a value of 11. Aggregate expenditures fall-short of full employment real production causing economy-wide product market surpluses. These surpluses trigger lower product prices, again economy-wide, which result in a decline in the price level. This adjustment continues until the price level once again reaches the equilibrium value of 10. As the price level falls aggregate expenditures increase, but full-employment real production does NOT change. Aggregate expenditures rise to meet full-employment real production.

  • Now suppose that the price level is below the equilibrium, such as a value of 9. Aggregate expenditures exceed full employment real production causing economy-wide product market shortages. These shortages trigger higher product prices, again economy-wide, which result in a rise in the price level. This adjustment continues until the price level once again reaches the equilibrium value of 10. As the price level rises aggregate expenditures decrease, but full-employment real production does NOT change. Aggregate expenditures decline to meet full-employment real production.
In both cases, the price level moves toward the equilibrium price level. And when it does aggregate expenditures change to match the full-employment level of real production.

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Recommended Citation:

DISEQUILIBRIUM, LONG-RUN AGGREGATE MARKET, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: June 20, 2018].


Check Out These Related Terms...

     | long-run aggregate market | equilibrium, long-run aggregate market | aggregate market | disequilibrium, aggregate market | disequilibrium, short-run aggregate market | equilibrium, aggregate market | aggregate market analysis | short-run aggregate market | equilibrium, short-run aggregate market |


Or For A Little Background...

     | aggregate demand | aggregate supply | aggregate expenditures | macroeconomic sectors | macroeconomic markets | long-run aggregate supply | aggregate demand curve | long-run aggregate supply curve | price level | GDP price deflator | real gross domestic product | equilibrium | full employment |


And For Further Study...

     | output gaps | recessionary gap | inflationary gap | aggregate market shocks | self correction, aggregate market | Keynesian economics | monetary economics | classical economics |


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